We all know assets are good and liabilities are bad, right? So when it comes to assets, the more the merrier would seem to be a logical conclusion to reach. Think bigger better car, a bigger better office, a bigger better inventory racking system.
Well, like most things which are good for us, too much can also be too bad.
Why? Well, there is a direct inverse 1:1 correlation between assets and cash – increase one and you decrease the other (ok, you could borrow to buy your asset but the impact is pretty much the same for your business).
If your non cash assets are ‘too high’, then your cash is too low and you may end up struggling with your cash flow. Now that is not good. and, if you don’t have the cash it will also mean you may end up stretching your creditors just to pay for your bloated assets; or, you won’t be able to pay the tax man on time (not good these days especially for directors), or pay the super on time (not good either as the tax man can get in on this as well – plus your employees deserve better); or, you will go to your bank and say “Please help me! (ouch).
The answer as to what is the ‘right amount’ of assets is to start with the premise: you need to get the balance right for your business – not your neighbour’s business nor your competitor’s business but your business.
So what is the right balance? It was good of you to ask.
We think, like most things in your business, it is all about the customer. If it delivers value to your customer, then the answer is probably self evident.
We use financial modelling tools to quickly review the cash tied up in businesses we review. If you financial accounting data is in pretty good nick, these tools are pretty damn impressive these days – a lot better than what was around only a few short years ago. They really allow you to apply the mirror to your business (and the banks love them – it saves them doing a whole lot of work on your numbers). Plus, they have nice pretty colours and charts and they allow what if scenarios and lots more. If that sounds like a service which might interest you, just give us a call to find out a bit more. We work with tax accountants as well who want to stay focussed on their tax compliance work and we provide them with a ‘value add’ service for their clients which otherwise they would not offer.
Now for those of you who think you now have a get out of jail card to allow your customers to rack up a large debt with you which you don’t have to chase because ‘it adds value to the customer’, I’m now going to have to disappoint you.
There is a big difference between adding value and creating a monster through lax discipline. Just think of your role as a parent. Do you love to see those kids screaming in the supermarket then get the lolly they always wanted just because they could scream really really loud? Thought not. Think of your customer like your kid. Sometimes, tough love is needed to ensure there is mutual respect.
As one of my clients once said when he (finally!) got my message “You are right, I just told them (my customers) I was not their bank. If they wanted to pay outside normal trading terms then either pay me the interest at my OD rate plus 5% or borrow from their own bank. They quickly got the message I was an outrageous bank.”
PS don’t do this until you have worked out your Terms and Conditions and included all the stuff you need to have in them to do this properly. If you don’t think you have T&Cs or you have not had them checked since early 2012, you better get your lawyer to draft some up for you which fit your business (which is probably not such a bad thing as if you haven’t had them looked at since January 2012 you might have missed the introduction of a little thing called the Personal Property Securities Act which has changed more than a few things including issues such as retention of title and other security related issues which might impact your business. I’m not a lawyer so talk to someone who if they get it wrong you can sue their PI insurer. We can give you the names of some good lawyers suitable for your business if you don’t know who to turn to). Lastly, T&Cs generally only work if the customer has signed them or accepted them in some obvious way. Otherwise your brand spanking new T&Cs are just a pretty document with no real effect.
These days, if you have 30 day trading terms, customers paying in 45 to 60 days is probably reasonable to expect. 70+ days means they are probably having a lend of you and 90+ days and they are gloating over how they have got one over you.
Be careful in offering discounts to get the cash in quicker. As with most things, this can get abused – particularly by the big boys who will take the discount and still pay you on their normal trading terms (try getting the money back out of them again once they have deducted it from a payment – being on hold with a mobile phone company Help line will suddenly seem like a wonderful way to invest a few spare hours compared to the fun you are going to have getting back misclaimed discounts).
Stock or Inventory
You never want to run out of stock, right? Of course not, but that does not mean you need to hold 6 months stock either. These days, with lead time management being a function of many accounting stock systems, there is no excuse for not having ‘just enough’ stock. I would recommend you carry a little bit extra for those lines which if you ran out, would give you a competitive disadvantage. Again, don’t go overboard and think about things like lead times, re-order quantities, supplier response to quick turnaround orders etc. Which means you best talk to your suppliers about what they can do to help you out if you ever need their help ‘in a hurry’.
Don’t forget to look at your cash balances. it is another asset which should be looked at. I read somewhere that Bill Gates likes to have enough cash to meet a year’s expenses. Now that is a nice dream for many of us to have but it is also probably not going to happen this side of 2064. So maximising cash availability is a good thing but make it work for you as well. What you have it do in working for you is probably up to your appetite for risk and the return you can get at that level of risk. A good way to think about risk is to consider what would happen to your business if you couldn’t access it for another 30 or 60 days – or, what would happen to your business if it halved in value. If you have a lot of cash, you can always look at expansion opportunities as well. But, caution: expansion other than organic growth needs to be part of a carefully thought out strategy which the existing business can absorb without crucifying its operations. (Trust me on this one, far too many acquisitions are done with apparent whimsy as the attention to detail has been woefully lacking and the apparent 1+1 = 3 synergy benefits evaporate within weeks and months of the acquisition – but hey, if you aren’t measuring these things who will ever know).
Always a tricky one. Because once you have them it can be hard to scale down quickly and cost effectively. So the answer here is to think carefully before you buy. Do the maths. Understand what return on investment you need to make any purchase a safe decision. And if this all sounds like it is a bit hard and mathematical, get your accountant to help you – what, they only do tax returns? Then give us a call.
You know the ones your accountant set up so you could get money out of the company without paying tax and without having a Division 7A problem. (You have loan accounts but haven’t heard of Division 7A? Better speak to your tax accountant and make sure they are watching your back. Or the Tax Man will cometh and he will reap what you have sowed. Plus some penalties as well). Remember, the tax man will expect they will be paid back over time. Just make sure you have them in your personal payment plan.
Now stand in front of the mirror and check that asset size again and let me know if you think you look ripped.